New revenue estimates from state economists are likely to make things much tougher for lawmakers as they attempt to wrap up deliberations on the state’s FY2015 budget. The annual Consensus Revenue Estimating Conference was held in the Capitol yesterday, and economists from the Department of Treasury and the legislative fiscal agencies agreed on revised revenue forecasts which are down significantly from their previous estimates in January. However, while most press accounts have highlighted the downward revenue revisions, there was a silver lining as well: revenue growth is expected to continue to be healthy over the forecast period.

The January forecasts lead to headlines about expectations of a $1 billion state surplus. Unfortunately, as shown in the table below, the new estimates will offset much of those projected gains.

State general fund/general purpose (GF/GP) revenues – essentially the state’s base of discretionary revenues that drive budget decision-making – are now forecast to be $253 million lower than expected in the fiscal year that ends September 30. Further, these revenues are estimated to be $221 million and $290 million lower than expected in FY2015 and FY2016, respectively. Estimates of the amount of tax revenues deposited into the School Aid Fund – the state’s second major fund which is the backbone of K-12 education financing – are down $64 million from earlier estimates in the current fiscal year and down by close to $80 million in each of the two following years.

However, while the results of the revenue estimating conference will make matters more difficult for state policymakers as they attempt to wrap up FY2015 budget deliberations, the one positive that comes out of the conference is that future revenue growth remains strong. The revenue revisions are largely due to adjustments to income tax projections tied to investors’ responses to proposed tax changes that were part of the federal “fiscal cliff” deliberations back in 2012. After making this one-time adjustment, annual revenue growth is still anticipated to be in the neighborhood of 4 to 5 percent for the general fund and just over 3 percent for the School Aid Fund, consistent with the growth rates projected in January.

Adjusting the Budget to Reflect Revenues

That, however, won’t take the sting out of the budget adjustments that will be necessary to bring things back into balance for FY2015. As lawmakers in Lansing attempt to conclude their deliberations on the FY2015 budget, the revisions create a new GF/GP budget hole for FY2015 that lawmakers will need to address.

The lower-than-expected revenues won’t pose an immediate problem for the FY2014 budget year that ends in September. A $1.2 billion GF/GP balance coming into FY2014 will provide a buffer. That balance was expected to decline to around $600 million by the end of FY2014 even before these revenue revisions. Now, with lower revenues, current year spending will eat away a little further on this balance, with the year-end balance falling into the $350 to $400 million range depending on final state spending figures for the current year.

But that leaves less revenue to carry into FY2015, and this is where the new budget challenges begin. Both the House and Senate have already passed their budgets based on the earlier revenue estimates. Now, the FY2015 budget takes two hits based on these new estimates: (1) a loss of around $200-250 million in the state’s GF/GP “bank account” coming into the new fiscal year; and (2) the loss of $221 million in anticipated revenue for FY2015. That means revenue resources for FY2015 are suddenly down by over $400 million.

CRC estimates that the GF/GP appropriations contained in House and Senate bills exceed available revenues for FY2015 by somewhere around $350 million – equivalent to roughly 3.5 percent of those totals. That means some combination of difficult choices for lawmakers, including:

Raising revenues – Never popular in an election year, but an option nonetheless. Among the options, a package of Senate bills to reinstate a use tax levy on Medicaid managed care organizations is currently before the House and would generate more than $150 million in additional net GF/GP revenue as well as over $190 million in new revenue for the School Aid Fund.

Cutting spending – The House budget exceeds the Governor’s original proposal by $115 million; the Senate budget is $92 million above the Governor’s proposal. Lawmakers may need to give back some of these budget enhancements. On the House side, however, that increase above the Governor’s proposed budget is driven largely by new GF/GP road funding.

Using “Rainy Day” revenues – The state’s Budget Stabilization Fund balance currently sits at $508 million with an additional $75 million deposit planned for the current year. Both the House and Senate FY2015 budgets contain additional pay-ins of $100 million. Eliminating (or reducing) these new deposits would free up revenue to address the looming shortfall. However, with the potential for $192 million of the existing BSF balance being used as part of the Detroit bankruptcy deal, this would mean at least pausing the recent trend of building up rainy day reserves.

Next Steps

Legislative leaders are likely meeting even today to work out a “target agreement” for the state budget – essentially a road map for each budget subcommittee which sets a limit on GF/GP funding for each department. If the Legislature is to meet it’s goal of completing the budget by June 1, that agreement will need to be completed soon, and it will tell the story as to how policymakers have decided to tackle this new budget hole.